The stretching (and ripping) of social fabric | Margin of Safety

In an ending scene of the academy award winning movie - Joker. A scene of anarchy and chaos plagues the city as the world sinks into chaos.

A familiar scene in America appears to be seen today. Where real life replicates reel life or perhaps the movie reel was highlighting a real serious problem of segregation of classes. If you look at history, it has shown that the human society has been separated by many things.

1. Religion: Catholic vs Protestant (IRA and the bloody sunday). Closer to home the Maria Hertogh riots
2. Race class: The American civil war of the 1960s was a result of the long-standing controversy over the enslavement of black people.
3. Ideology: In more recent times, the HK riots fundamentally is a clash of values and ideology of human rights, freedom and boils down to democracy vs autocraccy.

Further down the line, many have begun to highlight the problem of rich-poor division and the separation of social economic statuses (SES) that could potentially rip society's fabric apart.

A very valid problem for the world and more so the developed nations where so much money has been accumulated in so few people.
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Now one must be careful not to villi-anise the rich. For a poor man has never provided us a decent wage or a job. In contrast, a reasonable tax structure as well as management of tax coffers is necessary to ensure everyone is taken care of. But of course, its a competitive world and too high taxes will also drive people away (as the rich practices tax arbitrage).

And perhaps there's no better example than the city of Norway which has thoughtfully balanced all the different aspects. The transparency of the salary, the good stewardship of their wealth fund and investments as well as the pension structure that ensures nobody is left behind.

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In Seth Klarman's Margin of Safety. It must be remembered that the greatest challenge for an investor is maintaining required discipline. Standing apart from the crowd and not chasing stocks in periods of overvaluation.

1. Waiting for the right pitch

• The best analogy would be that of baseball. In figuring out how to bat a 400, Ted Williams necessitates that he doesn't swing till he knows it is in his sweet spot and the more i reflect, the more i seem to understand that this may differ from people to people.

2. Complexity and variability of business valuation

• Because of the credit cycle, the inflationary environment and the changing circumstances around a business - what worked out in the past may no longer hold true today. Remember, cars replaced horses and even in technology iPhones replaced the nokia phone, the latter whom used to control 40% of the phone market.

3. Ensuring sufficient margin of safety

• Buying at a significant discount to underlying business value and having a preference of tangible assets over intangible assets.
• Investors should pay attention not only to whether but also why current holdings are undervalued. It is critical to know why you have made an investment and to sell when the reason no longer applies.
• Look for catalysts that may assist directly in the realization of the underlying values.
• Give preference to companies having good managements with a personal financial stake in the business
• Diversify your holdings and hedge when it is financially attractive to do so.

Value investing shines in a declining market. Value investing is simple to understand but difficult to implement. For the hard part is discipline, patient and judgement.

Investors need discipline to avoid the unattractive pitches, patience to wait for the right one and the judgement to know when to swing.

And for where the world appears to be right now....does seem to be Chapter 1 of covid-19, battle for supremacy among superpowers and a fundamental shift in the world challenging the social fabric.

It pays to be patient for now.

A crisis which nobody knows

In the words of a prominent head of banking in Singapore. "Stock markets (prices) have gone to hell and back."

As I sat there listening, I pondered what exactly was happening in the markets?
Howard Marks Memo places it quite clearly - What does the U.S. see today?

• one of the greatest pandemics to reach us since the Spanish Flu of 102 years ago,
• the greatest economic contraction since the Great Depression, which ended 80 years ago,
• the greatest oil-price decline in the OPEC era (and, probably, ever), and
• the greatest central bank/government intervention of all time.

There seems some points in time when the market was literally throwing everything away, it seems that was due to:
1. Borrowed money, as margin calls were happening, private funds were selling.
2. When a crisis occurs, all assets suddenly have a correlation of 1, and all assets fell in prices.
3. Cutting the interest rate to 0, spooked markets even more.

But when the USA central bank mentioned that they would do Quantitative Easing Infinity, it brought back hope to the markets and a massive rally of 28% occurred. Under QE, they would buy treasuries. They later went on to buy junk bonds.  (Not announced yet) The last thing they could do is buy equities.

After all, the key saying is don't fight the FED (central bank of America).
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Bearish calls
As markets went further up on the rebound, many people were betting it would drop down. And as it went further up, less people thought so. Even Goldman Sachs gave up on their 2000 estimate...

But is it really over? Following prominent investors call, everyone of the following names made a bearish call.

3rd April - Howard Marks
14th April - Mark Mobius
22nd April - Paul Singer
28th April - Jefferey Gundlach
30th April - James Bianco
3rd May - Kevin Smith, CFA

James who? Kevin who? - Yes, I haven't heard of these two chaps before but when markets run out of brilliant minds to ask, they ask the younger talents hoping to make a name for themselves. But Kevin has a CFA as well so respect from one charter to another.

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Key thoughts of experts
So as we were all wondering if we should have bet the house on March 23rd...I think the following opinions are right:
1. Jeffrey Gundlach: If the markets were really that good, we would not need all this stimulus measures to begin with.
2. Howard Marks: The world is more than 15% screwed up.
3. IMF projections - first ever global recession of -3% decline in 2020 and 5.8% bounce in 2021.

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And the bull case:
TL:DR. Markets are forward looking and it would be fixed in a year (markets project 6-9 mths ahead)
https://www.marketwatch.com/story/the-stock-markets-rallying-while-the-economys-tanking-it-all-makes-perfect-sense-2020-05-02

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The Oracle of Omaha
- Warren Buffett recently had an AGM
2-men AGM: https://www.youtube.com/watch?v=69rm13iUUgE

He said a few things:
1. Don't bet against America (in the long run)
2. Our cash pile of US$138b is not much under the worse case scenario
3. The repercussions of shutting down the economy is unknown and the financial possibilities are very vast (while the health possibilities have shrunk neither worse case nor best case are in the list).
4. During 08-09, the effects of the crisis didn't happen on day 1. i.e. The effects will take a while to be understood by the market.
5. The world has changed for airlines. (And therefore he sold everything), as passenger miles traveled is unlikely to return to the same level in the next 2-3 years.
6. Warren bought nothing in March as nothing was attractive enough.

I did observe that Mr Buffett wasn't his cheery self, it does bring some concern when Warren is fearful.
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My thoughts on what to do during this period?
1. Copy the rich. Re-inventing the wheel is not only foolish, it is a waste of time. Buy when owners are buying in (and buying in big)
2. Keep learning (I bought more books, signed up for masterclass, listened to more financial articles).
3. Be patient. For opportunities will surely come by in the next 2 years (Aim for a homerun and bat for 400).

Regarding the covid-19, it is clear that
- The world is consumer driven, two-thirds of spending are consumer driven. Given that there are job losses of 10-30% of the world....this is really unprecedented for B2C and C2C companies.
- The world has changed significantly, people are working from home, digital tools are the vogue and many old industry jobs are probably forever gone while the new era has been accelerated.
- Sad but true, the rich poor divide. The challenges of society, nationalism, racism, xenophobia are all being exacerbated and brought to light. As a friend said, covid-19 has brought the best and the worst out of people.

But the one certain thing is that until a vaccine is found - there is no return to normal. And that is a very worrying thought as we all ponder how long can businesses survive under the subnormal economy of being at 80%-90% of the usual (or 0% under lockdown).

Certainly, the most important thing in this uncertain time is to Stay safe and stay healthy. 

Nevertheless, to end on a positive note - always remember the below quote by Zig. 
I suggest you read it twice for (second time slowly for the needed impact).

Musings from the market - Fed Rate cuts, Eagle H Trust, Ascendas Reit

Another rate cut
As the Fed announced their 3rd rate cuts of the year. Guidance is 1.5%-1.75%. They said they would pause for now. We all begin to worry whether if we are heading to a subzero environment. As mentioned by experts, a rate cut may be good or bad depending on your perspective.

It is good for borrowers (e.g. home loan borrowers) as this reduces the interest rate they pay. Assuming that the banks pass on the savings. Unpaid advertisement: DBS online home rate is now 1.86% fixed for 2 years. That’s a really fantastic rate to do refinancing or purchase of a new house if you are considering one.

It’s horrendous if you a saver, the deposit rates are dropping. Even the local SSB gives 1.56% for first year and 1.71% for 10 years. A better solution would be to go to specialised saving accounts like DBS Multiplier, OCBC 360, UOB One account, Bank of China to mention a few....you do need to meet certain criteria so that you qualify for the 2%++ interest rates.

It appears bad if you are a bank. But that depends if you can borrow at even lower rates and lend it at a higher spread. We need to observe the NIM or net interest margin to see how the local banks manage this. Nevertheless they are looking to alternative streams of non interest income and the market appears confident of this pivot.


The 2nd musing relates to REITs

Eagle H Trust
Everyone knows REITs are on fire because of the Low interest rate environment. Cash and bonds are heading towards 0 worldwide and so fund managers are looking at equities that provide steady recurring income.

Who knew that REITs could be burnt even in a good environment with a REIT like Eagle H Trust that appears to have loss the trust of investors as it falls to an all time low since it’s IPO. Imagine investing a dollar 5 months ago and today you take home $0.68. A total value destruction of 32% and the show isn't over yet.

I think beyond the normal physical real estate assets. Any other form of assets such as ports, ships, ships as hotels, television broadcast, golf courses can be a hard game to play because it involves very different way to value and estimate the cash flow.

Additionally, given substantial shareholders are selling out. At best, they don’t think the price will go up. At worse, they think the price will fall. Somewhere in the middle is probably paying taxes or saving on taxes through capital loss capture.

I think it is so bad that experience tells me to avoid such things as investments. My bad experience (lucking out when it matters include noble group, Hyflux perps, QAF and Sembcorp Industries). Since I am not exactly good on short term predictions, I won’t speculate either in trying to bottom fish.


Ascendas REIT 
This is a different case. The kind of manager with a track record of delivering value for its unit holders. The issuance of rights to acquire 30 US properties is an excellent opportunity for existing and new investors to join the game.

The Bankers are smart to underwrite because they can get 6%+ yield on the 2.63 price.

Certainly the 17% discount is attractive and taking a long term view would see this as a good investment.

My bugbear is the tradable rights which often have a history of dragging the mother share price down. I have seen this with Keppel REIT, OUE C REIT, Chip Eng Seng, Kep-KBS to name a few.

So I would think it may be wise to watch the market price action and be fully aware that A REIT price may fall. That being said, this still is a valuable quality portfolio of assets that are diversified across SG, AU, EU and now USA. In business parks, industrial assets, logistics and offices.

There is just one conclusion - Whoever takes part in the rights subscription will simply be better off.

And as the richest man in Babylon says - This is how you make your gold work for you by putting it to work.

The paradox of yield

In investing, people often seek a high yield. The equation of a yield generally means the annualised payout divided by the price of the asset.

The higher the yield the better. True or false?

Answer: It depends.

More accurately, it depends on the hat you are wearing. Are you a bond investor or an equity investor

If you are a bond investor or a lender and you can safely ascertain that no defaults or losses will be incurred, the higher the yield, the better. This is because you are on a fixed payout and a final bullet payment of principal at the end.

If you are an equity investor. Then it truly depends. For two key reasons. Equity investors earn by two methods, capital gain and dividend payouts.

• A high yield gives a high payout return but makes it difficult for managers to hunt for new assets to grow the pie.
• A low yield gives a low payout but makes it easier to find yield accretive assets.

And truth be told. With over 12 years of investing experience in anything from penny stocks to blue chips to indexes and bonds and foreign stocks...The secret sauce lies in this. 

Dividend growth. The best stocks are the one that grow its DPU or DPS year in and year out. Even better if they didn’t have to raise more capital for that.

So in that case. It is really a no brainer for reits that are able to grow their dpu both organically (rental reversions/ create new rental space / Govt measures to increase plot ratio etc) and inorganically through acquisitions of new assets:

For that reason. The low yield environment makes it the right time for sponsors to divest. In fact they would be foolish not to. This explains the record 2.3bln raised, highest since 1999 https://www.businesstimes.com.sg/real-estate/singapore-reits-going-on-a-record-fundraising-spree

And we are not done with the year yet. Q4 has only just begun...

Here are the perspectives:

1. It is definitely ripe time to sell assets for sponsors given the very optimal price as a result of yield compression. As markets price for a lower yield, the price of assets goes up.

2. It is definitely suboptimal to put your money in negative yield assets or zero yield assets. Investors therefore have to buy assets in the struggle for financial freedom.

Which is a fantastic thing because suddenly the good old DBS brought in so many USA based assets. Truly the right time for the right product.

Nevertheless, not all products are the same and we should continue our selections with extra vigilance.

This time it's different

As a keen observer of financial news. It does appear that we are approaching startling times. People have a very low aversion to the risk in the market and when that is normally the case, we may expect corrections and bear markets to precede.

Here are 3 key observations that are at the top of my mind:

1. The bond king's warning of recession in the next 15 months:
Jeffrey Gundlach is the guy who predicted the housing bubble, Donald Trump's 2016 win and most recently the likely spike in gold prices (and even bitcoin).

His track record has almost been prescient in all the times. Maybe a bit late or early but generally right. This is because he avoids listening to others and instead tunes in to the facts and financials that are actually happening.

Howard Marks once said, many scenarios could happen but only one would happen. So which is it?

I believe the flashing signs of all companies world wide reporting falling earnings, increasing bank jobs cut and coordinated world wide central banks cut does indicate this economic cycle is ending.

Winter is coming and we should be ready. The probability is 40% before the next presidential election (Ray Dalio) and probably 100% after the next USA presidential election.

2. The blackswan which is Hong Kong protests:
As someone who use to own HK stocks through the index fund and Mapletree NAC. I was ignoring lots of signs when the protests happened. Some HK people reportedly asking how to move to Singapore. About a million troughed the street and even professionals like civil servants and lawyers and teachers joined in.

What really got my attention was when Steve eisman called it the potential blackswan of this Moment. For those who aren't familiar, Steve was the hedge fund manager featured in the big short who got the reading right on the last financial crisis.

With share prices falling and no abating of the protests. I spoke to a more experienced friend of what would happen. He said this time it's different from 2014. Business owners and most of HK is supporting this movement. It will not end well.

That was enough for me to call it quits as I exited all HK positions. The risk of having 6% yield and 10% index gain no longer make sense when a rubber band stretched beyond a certain point is held there for too long.

HK's chapter is unfolding and certainly the country will likely be changed by what is to come.

Yet HK still features brightly as the gateway to China and as a location with great financial talent and smart people. It pays to revisit this story once the dust settles. But certainly I don't think the entire risk has been properly priced in currently.

3. The falling yield worldwide including Singapore bonds:
Singapore controls inflation via foreign exchange. This recently led to USA branding us as a currency manipulator. Whether it's true or not is up for debates. I for one think each country must do what it can to make life better for its own people.

But more interestingly, we saw the inversion of the yield curve in usa where 10 year yield fell briefly below that of the 2 year.

DBS analysts also said SG will benefit from this low yield environment. Very true. We can borrow money to invest in our infrastructure such as airports, property, digital hubs, new roads etc.

Conversely, as a fan of SSB - some people say the rate now 10 year rate being below 2% is very unattractive. I think this is a fallacy.

What I see right now is that it is going to be lower for longer. 10 year sgs currently trades close to 1.69%. which gives all investors in Singapore an opportune window to buy SSB right now to get 1.95%.

After all, the magic of SSB is not meant to be in just savings but the put option and capital protection where you can sell it back anytime at par.

At some point in the future, I expect yield to spike especially when the trade war leads to inflation. In that case, SSB is shielded from capital losses.

Recommendations and picks

1. I believe Kep Infra Trust being shielded from business cycles will do very well. Add on the falling interest rates of SG and AU, they will flourish and investors will appreciate this in time. I expect a 20-25% return inclusive of dividends.

2. Hard metals are good forms of insurance. Yet gold has moved quite a bit already. I believe silver has an opportunity and I expect a potential 30% upside in silver.

3. The CEO of L Catteron Ravi Thakran once said the best hedge against economic cycles is a quality business with quality management. I believe so. That why I think Berkshire Hathaway with its quality art pieces in the form of companies as well as an excellent management team, solid cash flow and big pile of cash at 130bln has placed it in the ultimate deal making position. Even Bill Ackman believes in him right now.

Conclusion:
3 stories tell of the ending of this economic cycle.
My position right now is that we should invest in defensive themes, local growth stories and always keep a keen eye for bargains.

Regards

Fortune REIT (Top notch investor relations)

I recently looked into a hot favorite of institutional banks, private bankers - Fortune REIT listed on SGX and HKEX market....I must say that while I am not impressed with the yield. The book value was attractive enough to consider a look. Below are my findings from a very RESPONSIVE Investor Relations. Thumbs up guys.

Here's the very useful information for you guys to start with.

Query

Hi there, I am a retail investor and I like to understand more about the assets in terms of.

1. Remaining tenure (leasehold / freehold)
2. Weighted Average Lease to Expiry (WALE) and Weighted Average Lease Term (WALT)of the portfolio as a whole
3. Interest coverage ratio & weighted average debt maturity?

4. Any additional future plans from the management looking beyond HK assets?
5. What the management is doing differently from its competition to retain tenants/attract tenants?

Appreciate the details. Thank you!

Response

Land tenure

Land in Hong Kong basically all belong to government and therefore are all leasehold. Similar to most other leases in Hong Kong, majority of the land lease of Fortune REIT’s properties expire in 2047 with two of them expiring beyond 2047.

Lease Term and Lease Expiry

For the new leases commencing during 2018, the weighted average lease expiry based on the date of commencement of the leases was 2.0 years. As at 31 December 2018, the weighted average lease expiry was 1.5 years.

Interest coverage and debt maturity

Interest coverage based on earnings before interest and tax (EBIT) in 2018 was 5.9%.  Fortune REIT’s gearing was 20.9% as at 31 December 2018 with no refinancing needs until 2020.  As at 31 December 2018, Fortune REIT has total outstanding debt of HK$8,505M with HK$3,505M (41.2%), HK$3,800M (44.7%) and HK$1,200M (14.1%) maturing in 2020, 2021 and 2022 respectively.

Investment strategies

Our investment mandate allows us to invest outside Hong Kong while our current focus would still be in Hong Kong neighborhood malls.  We like the resilience and income stability of the non-discretionary retail.

Asset management

We have been doing a good job in retaining quality tenants in our portfolio as our tenant retention always remains high (> 70%). Proactive asset management forms part of our overall growth strategies.  We always aim to negotiate lease renewal with tenants in advance, regularly optimize tenant mix to keep Fortune Malls relevant to shoppers and proactively engage our customers through exciting festive promotion.

Should you have any further questions, please feel free to let us know. Thanks.

Secondary fundraising - Rights issue (The tale of Keppel KBS USD Reit)

REITs are one of the favorite tools of investors, they give predictable dividends, easy to understand and generally have the nature of democratizing ownership of an otherwise very illiquid asset such as a shopping mall or malls.

Unfortunately REITs also have a strategy to grow its dividend and opportunity sets are limited due to only 10% of capital retained and a 45% gearing cap set by the regulator.

As such, to acquire new assets. A company needs to raise funds either by debt, equity or a mix of both (e.g. perpetuals).

In recent days, there were many destructive deals of the sort
1. OUE Commercial REIT
2. Kep KBS Reit
3. Cromwell Reit (not looking at this deal yet)

OUE Commercial REIT generally dragged its share price all the way down from the mid 60s to just 10 bps above its right issue price. You may also look at the NAV and DPU dilutive damage that the corporate action taken on its price - https://risknreturns.com/2018/09/15/oue-commercial-reit-rights-issue-a-case-study-of-value-destruction/

Kep KBS Reit represented the quickest destruction of value for its early adopters at USD 0.88 per share. Today it trades at USD 0.54. Taking into account its 3.82cents distribution, this represented a lost of 43% for the existing shareholders assuming they do not subscribe for their rights and do not sell it either.

Personally I was interested in USA assets because they are direct proxies to a growing economy and the resurgent economic power. But being very aware of the ground zero nature of rising interest rates. One needs to be very careful on this matter.

I did my calculations, and I do believe a lot of value is starting to emerge.

Pros:

1. Attractive yield at 10.355% compared with fund Nareit 3.32% yield, Manulife reit 7.89%

2. Macro trend of improving USA economy will bode well for assets

3. Semi-protected from aspects of trade war due to locality

Risks:

1. Manager may be impatient to offload other assets (another acquisition worth 10% of AUM is being looked at)

2. Large exposure to rising interest rates (3.47% effective IR. Increase is mitigated by 75% swop floating for fixed. Aggregate leverage relatively low at 33.3%) 

3. Large number of tenants (400+) could make it more challenging to manage. Also Tenant quality may not be too certain (not entirely well known names apart from Occulus)

4. Possible revision to USA Tax policy could result in 30% reduction in dividends received

Conclusion

It would be interesting to be able to get the shares as close to USD 0.50. And this taking into account the worse case scenario of 30% dividend reduction (result of dividend withholding tax) and 5% effective interest rate (additional 5.385m of interest expenses). We would get a DPU of 3.452 cents and this gives about 6.9% on USD0.50. If interest rate remains the same, we would get 7.8% yield even with the 30% dividend reduction

- Not too bad a deal if the max downside is 7% yield while the upside is up till 11.2% yield.

- Margin of safety appears to be pretty thick if we are income investors.

- Likely company is under-priced due to rights issue, size of REIT and lack of understanding by investors.

Certainly private placement (issuance to institutional) or usage of perpetuals (hybrid instruments that receive regular dividends) bodes well for shareholders. It is quicker, cleaner and the discount doesn't kill the share price. Unfortunately it is often not an option for small cap REITs.